Business Context and Reporting Period
The Sherwin-Williams Company develops, manufactures, distributes and sells paints, coatings and related products through The Americas Group, Consumer Brands Group and Performance Coatings Group. This unaudited Form 10-Q covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.
Key Financial Metrics
| Metric | Q2 2019 | Q2 2018 | Change |
|---|---|---|---|
| Net sales | $4.878 billion | $4.774 billion | 2.2% increase |
| Gross profit | $2.181 billion | $2.039 billion | 7.0% increase |
| Gross margin | 44.7% | 42.7% | Up 200 basis points |
| Income before taxes | $675.7 million | $538.1 million | 25.6% increase |
| Net income | $471.0 million | $403.6 million | 16.7% increase |
| Diluted EPS | $5.03 | $4.25 | 18.4% increase |
| EBITDA | $908.0 million | $778.0 million | 16.7% increase |
| Metric | Six Months 2019 | Six Months 2018 | Change |
|---|---|---|---|
| Net sales | $8.919 billion | $8.739 billion | 2.1% increase |
| Gross margin | 43.9% | 42.6% | Up 130 basis points |
| Income before taxes | $974.6 million | $841.7 million | 15.8% increase |
| Net income | $716.2 million | $653.7 million | 9.6% increase |
| Diluted EPS | $7.65 | $6.86 | 11.5% increase |
| Operating cash flow | $758.0 million | $579.1 million | 30.9% increase |
Liquidity, Debt and Capital Allocation
- Cash and cash equivalents were $145.6 million at June 30, 2019, compared with $155.5 million at December 31, 2018.
- Total debt was approximately $9.456 billion, representing 71.6% of total capitalization. Debt declined from approximately $10.375 billion at June 30, 2018 but increased from year-end 2018.
- Current ratio was 0.80 at June 30, 2019, compared with 1.01 at December 31, 2018 and 1.19 a year earlier.
- The company reported $2.734 billion of remaining short-term borrowing ability, including $1.234 billion of unused global credit agreement capacity. Commercial paper borrowings were $766.3 million at a weighted average rate of 2.8%.
- Six-month capital expenditures were $127.9 million, dividends paid were $209.8 million and treasury stock purchases were $450.5 million.
- The quarterly dividend increased from $0.86 to $1.13 per share. Management stated that, if approved for the remaining quarters, the 2019 annual dividend would be $4.52 per share.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven by higher North American store volume, selling-price increases and a customer program launched in 2018. Foreign-currency translation reduced Q2 sales by 1.5% and first-half sales by 1.8%.
- The Americas Group sales increased 5.0% in Q2 and 4.4% for the first six months. Consumer Brands sales increased 3.4% and 1.7%, respectively. Performance Coatings sales declined 3.8% and 1.9%, respectively, primarily due to softer demand outside North America and currency effects.
- Gross margin improved materially, while SG&A as a percentage of sales declined slightly in Q2 to 27.3% and remained 28.9% for the first six months.
- The effective tax rate increased to 30.3% in Q2 and 26.5% for the first six months, from 25.0% and 22.3%, respectively. The increase primarily reflected a $74.3 million tax provision related to the reversal of expected benefits from DC Solar renewable-energy tax-credit investments.
- First-half results included a $32.4 million domestic pension settlement expense. The company also recorded acquisition-related charges and continued Valspar integration and restructuring activities.
- The company adopted ASC 842 lease accounting in 2019, recognizing approximately $1.7 billion of operating lease right-of-use assets, $361.7 million of current lease liabilities and $1.362 billion of long-term lease liabilities. The adoption did not materially affect earnings, cash flow or debt covenants.
- Net operating cash increased by $178.9 million year over year, although working-capital requirements remained significant, including a $640.3 million increase in accounts receivable during the first six months.
Guidance, Outlook, Commentary and Risks
The filing does not provide a clear quantitative full-year sales or earnings guidance target. Management described financial condition, liquidity and cash flow as strong and stated that available cash and borrowing capacity were sufficient for current operating needs. Management expects continued benefits from North American volume, pricing and cost control, but identified softness in certain non-U.S. end markets and foreign-currency pressure.
- Litigation: The company had accrued $136.3 million for California lead-paint public-nuisance litigation. An agreement in principle would require the company and two other defendants to pay approximately $101.7 million each, subject to required approvals, with a potential maximum $15.0 million backstop for another defendant’s payments.
- Other legal exposure: Lead-paint litigation remains extensive and largely unaccrued because management believes losses are not probable or cannot be reasonably estimated. A Wisconsin jury verdict totaled $6.0 million against the company and two other defendants; post-trial motions and potential appeals were pending.
- Environmental liabilities: Accrued environmental liabilities totaled approximately $370.7 million, including $319.7 million in long-term liabilities and $51.0 million in current accruals. The unaccrued maximum of the estimated range exceeded the minimum estimate by $117.7 million.
- Tax matters: Unrecognized tax benefits increased to $189.8 million at June 30, 2019, with $182.6 million potentially affecting the effective tax rate. Federal, state and foreign tax examinations remain ongoing.
- Credit risk: Certain borrowings contain a 4.75-to-1.00 leverage covenant. The company reported compliance at June 30, 2019; default and cross-default provisions could accelerate debt maturities.
- Market risks: Results remain exposed to raw-material and energy costs, interest rates, foreign-currency movements, commodity prices, tariffs, economic conditions and acquisition integration risks.
- Regulatory matter: The South Coast Air Quality Management District notified the company regarding alleged non-compliant sales of denatured alcohol and indicated it intends to seek monetary sanctions; no specific penalty demand had been received.
Most Important Facts for Investors to Verify
- Reconcile reported EPS with the disclosed acquisition-related charges, DC Solar tax-credit investment loss, pension settlement expense and currency effects.
- Monitor refinancing or repayment plans for the $1.438 billion current portion of long-term debt, including the 2.25% Senior Notes due May 2020.
- Assess liquidity after seasonal working-capital needs, share repurchases, dividends and debt maturities, given the 0.80 current ratio.
- Track approval and payment obligations under the California lead-paint settlement agreement and developments in Pennsylvania and Wisconsin litigation.
- Evaluate potential changes to environmental accruals and the unaccrued $117.7 million range of possible environmental outcomes.
- Follow the DC Solar tax matter, ongoing tax examinations and the potential effect of $189.8 million of unrecognized tax benefits.
- Confirm whether management later issued quantitative full-year guidance, as this 10-Q does not provide a clear numerical outlook.